Affirm: The Recent Inflection In The Business Is Under-Appreciated

Summary:

• Affirm shares trebled in the last 2 months of 2023 before retracing about 1/3rd of the move.
• Affirm has recently extended its relationships with both Amazon and Walmart.
• The Buy Now/Pay Later space apparently achieved an inflection in volume over the Black Friday weekend.
• Published expectations for Affirm are quite modest considering its expanded partnerships and the overall inflection of the space.
• The company margin performance improvement was substantial and there are reasons to believe it will be sustained.

Why did Affirm shares treble in 2 months; what’s up next

Affirm (NASDAQ:AFRM) shares really did treble in the last two months without a whole lot of support from brokerage analysts or from commentators on SA. The shares currently are still rated as somewhat below a hold on average: out of 19 brokerage analysts who report their ratings to 1^st Call, only 5 have the shares rated as a buy while 4 rate the shares as a sell. Most recently, the analyst at Morgan Stanley downgraded the shares while the analyst at BMO initiated coverage with a Market Perform rating. Analysts have an average price target of $31.60, although there are a couple of significant outliers both positive and negative in that compilation. In my opinion, there is about as much misconception of this company as almost any equity I have seen. Some commentators have insisted that Affirm’s valuation is a bubble; others have proclaimed that its results were built on easy comparisons. I am going to try to bring some sense to a few misconceptions and suggest that the company’s business has reached an inflection point which has been unremarked by many commentators and yet needs to be better explored in terms of realistically evaluating the shares.

Besides consolidating after the significant run-up over the last two months of 2023, the shares are often viewed as a play on interest rates. There is a significant level of interest rate angst in the market at this point. As I wrote this a couple of days ago, the two year treasury yield has backed up by over 13 basis points because of the strong retail sales report. In turn, fixed income investors now are concerned that the Fed will not cut rates at their March meeting, and some investors are unnerved at the tenor of Fed speakers. From a point of view regarding Affirm’s likely financial results, the strong retail sales report, and particularly the strong growth of non-store sales is a decided positive.

The correlation of Affirm’s operational performance to short term swings in rates is not very great. It is the spread, and not the absolute level of rates that is important. I have no intention of trying to forecast short term rates or forecast a Fed decision at a single meeting. Doing so is little better than a guess-maybe worse. This is an article for long term investors suggesting that they take advantage of the recent share price consolidation and buy Affirm shares. It is not an article that is trying to discuss an appropriate trading strategy for the shares based on the perturbations of rates in the next weeks or months.

Despite the share price spike, the valuation of Affirm shares is not at anything like bubble levels. My projection of the current 12 month forward EV/S is around 5X. The company was able to generate significant free cash margins in its most recent quarter. I consider valuation based on both revenue growth and free cash flow margins. Using that methodology, Affirm shares still have a valuation well below average for the company’s growth cohort. This is an article reiterating my purchase recommendation for the shares of Affirm, even after their spike at current prices of $40/share. (price as of close on 1/18.24)

I do recognize that the shares will probably continue to consolidate until the company next releases earnings in early February. I should, at the outset, make clear that I have been anything but prescient in evaluating Affirm’s shares. While I recognized the bubble valuation that came in the wake of the announcement of the Amazon partnership in the late summer of 2021, I was overeager to revisit the shares. While the shares have trebled since the last time I wrote about the company for the SA site, I have also recommended the shares when they were $44 back in Feb. 2022. I have maintained a position in the shares for some time now: because I sold more than half of my position when the shares spiked in 2021 I actually have a modest profit in my current position.

As a long term tech investor I want to hold shares in companies that are leading vendors in a new paradigm. Because it is a new paradigm, many analysts have a difficult time of establishing correlations and reasonable CAGR estimates for a company such as this. There are really no good analogs. I will review the various factors that drove the valuation of Affirm shares so much recently. But the one factor that seemingly has not been given the credit it is due is the evidenced that recent months have marked an inflection in the acceptance of the BN/PL payment paradigm as an important factor in the payment space. That was apparently a significant factor over the Black Friday weekend, and all indications are that the trend has continued and will continue for the foreseeable future. As I will relate, apparently even the company’s leadership has been surprised about the inflection, setting up an interesting opportunity when the company reports results in early February.

I remain surprised at just how negative the analyst community remain on this company and just how misunderstood are the factors differentiating Affirm from alternative fintech investments. I suppose, on the other hand, it is this extreme reticence to acknowledge the company’s opportunities or its recent positive execution that still provides investors with a significant opportunity.

Affirm shares have spiked-was that froth and speculation or something real.

Most readers will know that the end of last year was a time of a furious rally in tech stocks. That, to be sure, set the stage for Affirm’s performance. The ARK Fintech Innovation ETF (ARKF) rose by 59% in two months before consolidating by about 10% since the end of last year. Affirm shares are not part of the portfolio of this ETF. But aside from the overall rally in the fintech space, there were 4 important developments that I believe animated the performance of Affirm shares; the shares were as much responding to these particular events as they were to the furious rally in the last two months of 2023.

The first of these events was the earnings release of 11/8. The results were a significant beat compared to prior expectations. I will review the earnings release in detail later on in this article, but overall headlines and other KPIs were well above the company’s prior forecast. In particular, the company reported operating margins of 12%; the company’s projection for non-GAAP operating margins had been 2%-4%. Interestingly, the earnings release itself had a relatively modest impact on the valuation of the shares; they rose only 25% in the days following the earnings release.

In the wake of the Black Friday shopping period, Adobe Analytics reported that spending via BN/PL services jumped 42% year on year. While overall on-line spending on cyber-Monday rose 10% to about $12 billion, spending via BN/PL rose a somewhat staggering 42.5% to $940 million. Self-evidently, that latter number marks an inflection. Why is the inflection taking place? I have linked here to a WSJ article which is a deep dive into why this inflection is happening now. For subscribers wondering about investing in Affirm shares after their spike, it is worth a read. Here are the salient numbers from the report:

A quarter of all American adult consumers have used buy now, pay later loans, according to LexisNexis Risk Solutions. Over Black Friday and Cyber Week, such payment plans accounted for 7.2% of all online sales, a 25% jump from last year.

Needless to say, these kinds of numbers are not part of current company guidance and they are not at all what is embedded in the 1^st Call consensus forecast for Affirm’s revenue growth. Consumers have apparently now decided that BN/PL is a reasonable way of obtaining credit for all kinds; perhaps a more attractive way of obtaining credit than the use of various kinds of credit cards. There are many reasons why consumers have increasingly made that choice including the fact that the use of BN/PL credit doesn’t show up on a credit report, that credit can be obtained despite relatively low credit scores and that the services don’t threaten to garnish wages in the event of non-payment.

Affirm has a much more sophisticated technology that goes far beyond credit scores to allocate credit and it has worked successfully as I will detail later in this article. Overall younger consumers are changing the way they acquire credit in order to maintain their spending. This is an underappreciated paradigm shift in my view, and it is at the core of my ownership and purchase recommendation of these shares. While I don’t anticipate that Affirm will report a growth of 42% in GMV-its projection, after all was for a growth of 30%-it seems reasonable to anticipate that the quarter that Affirm is going to report in early February is likely to show significant upsides to revenue growth metrics compared to the current consensus. ( I am not going to comment here on the morality of extending credit to sub-prime borrowers. I try to avoid making political or social comments in these article. I am trying to write about investments and not who should borrow or how they should borrow or how much they should borrow. I do follow various regulatory concerns about BN/PL; at the moment regulators are not actively involved in attempting to limit BN/PL arrangements).

A third positive factor specifically relating to Affirm’s outlook is its enhanced partnership with Walmart (WMT). In the middle of last month, Affirm announced that the company had placed 4500 kiosks in Walmart stores at which shoppers could use these kiosks for self-checkout and to use Affirm credit to pay for what they were buying. The shares jumped 15% on the day this was announced. It is more or less impossible to determine the potential for these kiosks to generate GMV; certainly the opportunity is not insubstantial and seems to be in line with the consumer behavior patterns outlined in the WSJ article.

Finally, early in November, 2023, Affirm announced that it had become the first BN/PL option for Amazon business. What the magnitude of that opportunity will be is indeterminate at this point anything with Amazon tends to be substantial. But it takes time for a new service available on Amazon to start generating significant GMV. What is more significant, at least in the short term, is that essentially Amazon has reaffirmed its partnership with Affirm, an element of some concern on the part of some investors.

While no analyst is ever going to be comfortable recommending shares that have seen a spike of the magnitude of Affirm it is my view that the shares had been egregiously under-valued previously. Even now, I think many investors and analysts have been unwilling to look at the most recent developments and reevaluate estimates for growth and for margins.

Taking a look at what Affirm reported for its latest reported quarter

Affirm is going to report it fiscal Q2 results on 2/8. But I thought it might be relevant to look at Affirm’s fiscal Q1 which closed 3.5 months ago. One thing to note: management made some fairly conservative assumptions in constructing the forecast. Self-evidently the cautions in those assumptions have turned out to be dramatically overblown.

The company forecast for Q1 had been as follows:

GMV-$5.3-$5.5 billion

Revenue-$430-$455 million

RLTC (Revenue less transaction costs) $175-$190 million

Adjusted operating margin-2%-4%

The company’s full year forecast was:

GMV of more than $24 billion

Revenue $1.9 billion

RLTC of $790 million

Adjusted Operating Margin of more than 2%

The company’s actual performance in Q1 was:

GMV of $5.6 bil.-beat of 4%

Revenue of $497 million-beat of 14%

RLTC of $212 million-beat of 19%

Adjusted operating margin of 12% (3X forecast)

As a result, non-GAAP EPS for the quarter was $0.16. The result was $0.13 greater than the consensus. The company does not explicitly forecast non-GAAP EPS, and most services do not show an accurate non-GAAP EPS metric, but the metric is easy enough to calculate.

The company’s full year forecast is now as follows:

GMV now expected to be greater than $24.25 billion

RLTC expected to be $800 million

Adjusted operating margin to be more than 5%.

The full year forecast was quite conservative; essentially the company simply incorporated the Q1 beat and kept the balance of its forecast unchanged. At the time the forecast was prepared, the decline in interest rates in the wake of the Fed’s revised set of dot plots and the significantly altered FedWatch tool were not anticipated by the company. In addition, the company’s forecast was predicated on an expectation that the resumption of student loan payments would negatively impact retail sales of some Affirm customers. Finally, the CFO had thought that the end some specific promotional programs with some Affirm partners would weigh on sequential quarter comparisons. The company’s Q2 forecast was even more conservative as there is a typical mismatch between revenues and provisions for credit losses. While credit losses are actually declining, the income statement last quarter included a significant increase in provisions.

Other than the timing issue with regards to provisions, none of the negative elements in the forecast have turned out. The impact of the resumption of student loan repayments has been negligible. Of course the company’s interest rate expectations has been turned on its head. And the inflection in demand for BN/PL was not foreseen-although to be fair, what inflections are really foreseen? As I write this article on a dull Wednesday morning, December retail sales were reported to have been strong and non-store retail sales growth for the period was very strong. These are obviously data that supports an expectation for better than expected GMV growth, although they also suggest that the 1^st Fed rate cut will perhaps not be in March as had been anticipated.

Affirm can be a difficult company to analyze because of its many different revenue buckets and the ever-changing mix of revenue sources. It would be extremely tedious to review all of the different sources of Affirm’s revenues. I am not sure to what extent a deep understanding of these different offerings is necessary in order to understand broad revenue trends for Affirm.

At the end of the day, Affirm is a consumer finance company that obtains funding through a variety of sources. Some of those are through sales of loan backed securities, and most of the sources are through partnerships with a variety of hedge funds and other capital sources. The company’s funding capacity has steadily increased. At the end of the September quarter, funding capacity had grown to $13 billion, up by 10% sequentially and up by 18% year on year. Over the course of the company’s fiscal Q2, the overall spread between the costs of obtaining funding capacity and the pricing/revenues for Affirm loans has likely widened. The pricing that Affirm gets from merchant fees has held at a consistent percentage level, overall, for some time now. I expect, however, that the pricing in the various buckets has risen last quarter, and will continue to increase over the next several quarters, somewhat a function of retail promotions.

The widening of spreads can be best seen on pg.8 of the company’s most recent shareholder letter.

The published 1^st Call consensus metrics for Affirm are essentially the same as the latest guidance. It bears repeating, I think, that there has been only 1 revision to estimates over the latest 30 day period, at least according to published 1^st Call data. I think the estimates both for the current quarter and the full fiscal year will see significant over attainment.

Affirm’s differentiators

There are plenty of BN/PL alternatives in the market. Square (SQ) acquired Afterpay. Klarna is a Swedish company offering BN/PL services in the US. PayPal (PYPL) has a BN/PL offering. What differentiates Affirm? At the end of the day it is simply technology that provides partners and ultimately consumers with far more flexibility in using Affirm and which has allowed Affirm to more accurately allocate credit. The number of incarnations that Affirm offers through its partners is substantial. There are 0% APR options, there are 4 and 8 pay options, there are standard offers that encompass purchases of as much as $25k and extend to 3 year repayments. The company’s adaptive checkout product is unique; it allows consumers to choose between options such as Pay in 4 and installments at checkout. None of Affirm’s competitors can provide merchants and consumers with so many options. And none of them have so far have been able to leverage AI to optimize credit decisions and to effectively manage default rates.

While to be sure Affirm competes on price, the ability Affirm has to tailor its offering to the particular requirements of a merchant has been a major factor in the high profile partnerships that the company has been able to build. It is hard to ignore that Affirm is Shopify’s (SHOP) BN/PL option, or that it has a significant partnership with Walmart that has just seen a major expansion. Of course Affirm is the BN/PL option for Amazon (AMZN) and that partnership was recently expanded to include Amazon Business. It is those kinds of partnerships that make headlines, but Affirm has also been successful in partnering with less known retailers such as Blackhawk Network (BHN) the leading distributor of digital gift cards, and Liberty Travel and Evolve, two significant travel industry companies.

The basic reason that Affirm has been able to thus far win the market share competition in its space has been its ability to leverage its proprietary AI technology. Using this technology has in turn, enabled Affirm to effectively optimize the delinquency profile of its borrowers. This is one element of the rather impressive improvement in margins recently reported, and it also has enabled the company to customize offerings for its partners. It is in the nature of a virtuous cycle with technology enabling tools to optimize delinquency performance which in turn allows the company to capture market share because of the flexibility and pricing it is able to offer partners and potential partners.

Part of the technology that Affirm has developed is incorporated into the company’s card product. Here is a link to the profile of the Affirm card product. The product seems to be taking off. The Affirm Card active consumer count has risen steadily to 400k at the end of last September. Active users have been rising at a 75k monthly rate for several months now. Affirm’s direct-to-consumer GMV, the bucket which is animated by the card rose to $224 million last quarter-the comparison with the prior year is not meaningful, sequentially GMV in this category rose by 90%. The card has similar economics to the rest of Affirm’s offerings; presumably at scale there will be more leverage. Of course I don’t expect that GMV growth for the card will remain at 90%, but it is an example of the leverage Affirm has from its technology investment and it is likely to be a revenue growth tailwind for the next several years.

Addressing some company concerns/misconceptions about Affirm; Trying to establish a reasonable CAGR

I am going to reiterate some of themes I have written about before, when I last wrote about Affirm and earlier in this article.

It has been asserted that Affirm shares have been animated by a “bubble” mentality. Of course there is no standard definition for a bubble. To me, a bubble is created when a stock appreciates rapidly, to an absurd valuation without any substantive news. Affirm shares did appreciate rapidly. But they did so in the wake of a variety of specific news events that are likely to mean that the company has exceeded its guidance for this past quarter and is likely to do so in the next several quarters. Affirm shares went up because the world changed. In the biotech space, stocks appreciate-and of course fall-by large percentages overnight depending on the approval or rejection of new drug applications. If there has been a growth inflection in the use of BN/PL in the last couple of months, then it is only reasonable to expect that Affirm shares would appreciate strongly. If that inflection actually has been confirmed by strong growth in a specific period then a further appreciation seems warranted.

Commentators are right to observe that there are several BN/PL alternatives as I pointed out earlier. They are not right to suggest that Affirm is losing share-the opposite is the case. And some commentators seem unaware of the major factors that differentiate Affirm from its competitors and will continue to do so. The fact is that Affirm is the industry leader in the use of AI to make credit decisions, and its technology provides the company with ability to offer partners tailored solutions that fit their specific requirements. And the technology embedded in Affirm solutions allows the company to be particularly transparent in the credit offers it makes to consumers.

Another misconception here is the so-called sweet deals that Affirm has given to Amazon and to Shopify. The exact terms of these sweet deals, so called, are not totally known and probably never will be. We do know that Shopify’s deal with Affirm involved significant ownership which was obtained by Shopify before Affirm’s IPO. Affirm has recently become the Buy Now/Pay Later solution for Amazon Pay. Amazon has also recently extended its Affirm relationship to Amazon’s small business offering. When commentators suggest that the Amazon relationship with Affirm will no longer be a growth driver, the facts point otherwise. After 2 years, Affirm’s BN/PL represents no more than 1% of Amazon’s volume according to the linked article. Amazon is still less than 20% of Affirm’s GMV. There is plenty of upside here without excessive customer concentration and equivalent upside with the Shopify partnership. It is these major partnerships that are, and are likely to continue to drive strong growth in GMV.

Overall, Affirm’s profitability is heavily dependent on volume. There literally is no other source of tremendous revenue opportunity with regards to retail credit of the magnitude of Amazon, Walmart and Shopify. It would have made sense for Affirm to price its partnerships with both Amazon and Shopify aggressively. Affirm tries to focus investors on unit economics which are improving. That is more than a hint that the company’s largest partnerships aren’t and will not impede the company’s path to improved profitability.

One significant misconception is that in some way Affirm is an analog of Visa (V). It is true that both companies have as their raison d’etre providing consumer’s credit. But the whole concept of Affirm and indeed of the BN/PL space is that credit card debt and the companies that offer it are held in the lowest regard by many consumers. The growth opportunity for Affirm is not as an analog of Visa but as a replacement for Visa, and the other credit cards through which consumer credit can be obtained.

The TAM for BN/PL is really unknown and any projection is likely to be little better than a guess. (The article linked above does provide such a guess-its forecast for BN/PL revenues-but the projection for this current year has already been run over by actual results.

Currently Affirm has 3 mega partnerships, i.e. with Amazon, with Shopify and with Walmart. Its share of purchases from those retailers is still very small. Last quarter, Affirm’s GMV was $5.6 billion. It’s projected GMV for the year as published is $24.25 billion. Based on the various Black Friday and Christmas holiday projections, my guess is that GMV will be $26 billion +, or 30% growth. The current projection of Walmart revenues for 2024 is $644 billion. Amazon’s net product sales are running at an annualized rate of about $250 billion. Shopify’s GMV is also running at an annualized rate of $250 billion. So, at this point, Affirm has a market share of less than 2% of the payments that are being processed by Amazon, Shopify and Walmart. Of course Affirm has partnerships with many other retailers. On the other hand, it is very early days for the recently announced partnership with Walmart to generate a huge amount of revenue.

The opportunity for Affirm over the medium/long term is to replace Visa and other cards as a consumer credit platform. That is exactly what the Adobe survey linked earlier in this article suggests is currently happening. Visa is a payment platform with an enormous volume of processed payments; of course it also supplies credit to consumers. Affirm is a credit platform that is used to make payments. Suggesting that the growth rate of Visa and Affirm are related is pretty farfetched at this point and into the foreseeable future. No one is suggesting that Visa is at threat from Affirm. The Affirm card, no matter how fast it can grow, is never going to replace Visa as a global payment method. The latest statistic is that Visa is facilitating $15 trillion in payments. Affirm’s GMV has currently reached a likely run rate of $30 billion.

Not terribly surprisingly, many consumers-particularly younger consumers-are pushing back against acquiring credit card debt. There are many reasons for that-the perception is that BN/PL is a lower cost way to finance a purchase that it is flexible and easy to use, and its use doesn’t affect credit scores. Transparency also seems to be a factor.

One thing that surprise me is the unwillingness of many commentators/brokerage analysts to understand just how early in the cycle BN/PL actually is. The Adobe survey and the WSJ are as clear signposts as there can be that BN/PL will continue to gain share in the consumer credit space for the foreseeable future. The three largest partnerships that Affirm has are only in their earliest stages and consumers are increasingly inclined to use BN/PL offers to pay for a wide variety of merchandise.

So, what’s that most likely percentage growth for the GMV of Affirm? Presumably, over time, revenue growth and GMV growth will converge, although because of the mis-match in timing for some reported revenue metrics, there will be quarters in which the two items will show diverging trends. There are more than a few wild cards in establishing some kind of reasonable expectation. Based on the Adobe survey, the WSJ article and the significant expansion of Affirm’s in-store partnership with Walmart, I think a reasonably conservative expectation for percentage GMV growth will be in the 30% range for the next 2-3 years.

That is a significant divergence from the 20% revenue growth shown by 1^st Call as the analyst consensus estimate for fiscal year 2025. Not to beat a poor horse, but the fact that there has been just a few analyst changes of estimates since the Black Friday disclosures by Adobe suggests to me that analysts, as is most often the case, will be raising estimates in arrears. Of course the difference between a revenue CAGR of 20% and one of 30% is a huge factor in my purchase recommendation.

Affirm’s business model-It is spiking along with the company’s share price

The biggest upside last quarter for Affirm was that of profitability the company achieved. To repeat, operating margins for the quarter were 12%, several times the company’s forecast of 2%-4%. As mentioned, Affirm can be a difficult company to analyze in a couple of pithy sentences.

For the sake of brevity, I will highlight the KPIs that I think are most relevant in looking at the company’s evolving model. The metric that is a typical focus of most analysis is that of Revenue less transaction cost or RLTC. That rose by 16% year on year last quarter, a significant upside to prior expectations. The RLTC metric includes “provisions” which often are mismatched with the appropriate revenue metric. Just looking at Revenue less transaction costs excluding provisions showed a sharp improvement, with 27% growth year on year in the latest reported quarter. The company showed significant expense discipline last quarter with all of its operating expense categories declining sequentially and year on year. In particular, the company’s technology and data analytics expense fell nearly 20% sequentially and by 22% year on year. Sales and marketing expense has been trending lower along with general and administrative costs which fell by 15% year on year.

Obviously the company is unlikely to reduce operating expenses significantly after the performance last quarter. The company CFO wasn’t quite explicit in terms of his expectation for hiring and opex trends. He did suggest that sales and marketing expenses would show a modest seasonal increase in the quarter to be reported in February. But opex doesn’t have to decline continuously for this company to significantly exceed its current 5% non-GAAP operating margin projection. The biggest factor in quarterly changes in non-GAAP margins for this company is that of provisions. In reality, that metric hasn’t changed much as a percentage of loans Affirm holds for investment. That is despite a declining delinquency rate over the course of the last 12 months. But further, the growth in bad debt allowances has exceeded the growth in charge offs noticeably. That is mainly a timing issue. Provisions aren’t likely to exceed the growth in charge-offs indefinitely.

Affirm’s model, at least in the short term is dependent on its mix of borrowing types. That can be complicated as it requires guesses on which kind of borrowing will be most popular for Affirm’s borrowers. There has been a tendency for Affirm’s revenue growth to be constrained because of borrowing type and this was the case last quarter. Affirm derives fee revenues from 0% loans; it gets a fee from merchants. It records interest income on other loans ratably. That said, last quarter overall RLTC grew 16% year on year, and by 16% sequentially. The RLTC margin reached 3.8%, at the high end of the company’s long-term model, and up from 3.3% the prior quarter. The company’s forecast, both for the quarter to be reported in February, and for the full fiscal year shows RLTC margins retreating from the levels last quarter. That seems quite unlikely with revenue growth likely to have accelerated and the cost of funding perhaps slightly lower sequentially, although there can be timing factors that impact the level of provisions recognized in a particular quarter.

Putting it all together, my expectation is that non-GAAP EPS for the next 12 months will be about $.52-$.54 based on a non-GAAP operating margin of 7.5% and 340 million shares outstanding. I estimate the company’s free cash margin will slightly exceed its non-GAAP operating margin. Provisions, which is part of the non-GAAP income statement is not included in cash flow; that is offset to an extent because of the amortization of premiums and discounts on loans and the gain on sale of loans. Last quarter, while the company’s operating margin was 12%, its free cash flow margin was 13% and its operating cash flow margin was almost 20%.

Affirm’s valuation and the case to buy the shares at this point

No doubt the 9 weeks till the end of 2023 saw Affirm shares appreciate far more rapidly and to a higher level than had been anticipated by most observers, this writer included. The fact is, though, that most observers had not anticipated the strong results Affirm delivered in fiscal Q1, they had not anticipated by the exceptional growth indicated for the BN/PL space reported by Adobe as part of its on-line marketing survey, and they had not expected either that Amazon would extend its partnership with Affirm to its SMB offering or that Walmart would substantially expand its relationship with Walmart with Affirm establishing 4500 kiosks within Walmart stores at which shoppers can use Affirm as their payment option. Of course, I think it is equally fair to say that the fierce rally in IT shares in the last 9 months of 2023 was equally unanticipated.

At this point, despite these developments, some of which are highly likely to produce operating results for Affirm that will be higher than its forecast, the analyst consensus for both the last quarter and the full year hasn’t changed significantly.

In addition, many commentators, are seemingly oblivious or worse as to why Affirm shares appreciated so much have lowered their ratings on the share. As of this afternoon, 1/18, Affirm shares have retraced about 1/3^rd of the move they made between 10/25 and 12/28 of last year.

I recognize that some investors will want to see more of a retracement before making new commitments in the shares that have still more than doubled from their recent low point. And the market itself has been wavering depending on macro data regarding inflation and interest rates and specific operating performance of some bell weather companies such as TSMC today.

I don’t purport to be able to provide consistently accurate trading advice. As indicated, I imagine that Affirm will once again show upside results when the company reports. Just how much the company will choose to reflect some of the trends observed in guidance for the balance of the year is something I really don’t know. Guidance last quarter was quite muted; it will be somewhat harder to credibly mute guidance due to how much conditions have changed since the company published assumptions as part of its fiscal Q1 earnings release.

Needless to say the company is nowhere near GAAP profitability. In addition to share based compensation which was 22% of revenue last quarter, down noticeably from 33% of revenue in the year earlier period, the company is amortizing the cost of the Shopify commercial agreement through its income statement at the rate of $96 million/quarter. It would take something like non-GAAP margins of 30% or more before GAAP profitability might be in view…that isn’t happening in the short term.

In calculating valuations I use the fully diluted share count that the company presented in its shareholder letter. Fully diluted shares were 334 million last quarter and were 323 million in the prior quarter. As I expect outstanding shares to rise 3-4 million/quarter, my valuation is based on a fully diluted outstanding share count averaged for the full year of 344 million.

As of today’s closing Affirm share price of just greater than $40, my estimate is that the 12 month forward EV/S ratio is a bit less than 5X and the company’s 12 month forward free cash flow margin will be 9%. Considering the combination of both of those metrics and a 3 year revenue CAGR of 29%, Affirm shares have a valuation of 20% below average.

There are those observers who seem fixated on numbers-presumably deciding on portfolio construction and stock selection is inherently quantitative I suppose. I am as guilty as anyone in deluging readers with lots of numbers at various points in my narrative. But at the end of the day, when I look at Affirm, I look at a company that has just seen a significant inflection point that will create additional and substantial opportunities underappreciated by many. Estimates are simply too low, for the soon to be reported quarter, for the fiscal year and beyond. Some years ago a president of the US derided what he called “that vision thing.” In my view, what is being missed by many is precisely “that vision thing.” Affirm’s future growth is a function of how popular BN/PL will become, the company’s ability to gain share, and to some extent the success of the Affirm card. None of those metrics is easy to know at this point; in my view the preponderance of the evidence suggests BN/PL is becoming a significant and rapidly growing alternative as a consumer finance solution, that Affirm has significant differentiators that are driving market share gains, and the Affirm card is seeing significant early success. As indicated earlier, I have held a position in Affirm shares for some time and intend to add to my position opportunistically. I believe the shares will produce significant positive alpha over the coming year.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of AFRM either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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